Friday, December 30, 2011

...so Nick Rowe's whole post here (HT - Tom Dowling) seems to depend on the zero-growth economy, and the zero-investing government, and he glosses over how crucial that assumption is to his conclusion (he starts relaxing these assumptions at the end and gets.. well... he pretty much gets Krugman's point about no inherent burden but potential distributional and incentive problems).

It seems that if (1.) the economy doesn't grow, and (2.) old people borrow from young people so they can simply consume more, it is trivially true that debt can be burdensome to future generations. This is true for any kind of debt - public or private. And it tells us very little about the way that economies in human societies actually work (which is our goal here as economic scientists, after all - we're here to understand human social behavior, not play around with OLG models).

I don't know why Nick is embracing a conclusion that is entirely reliant on unrealistic assumptions. When we're discussing something like a general glut Nick is always the first to point out how wrong this sort of approach is. So why is he doing it here? I don't know.

Nick often tells us that in the real world we trade with money and excess demand for money can spill over into other goods, causing a general glut. There is no market for money - money is traded in every market. Any model that abstracts from this is not reliable for dealing with the real world.

Well when we think about debt, we need to think about it in a world where the economy is growing and people borrow either as a result of time preference (they'll pay a premium to consume sooner) or expectations of a rate of return exceeding the interest rate. Under both of those more realistic assumptions, Nick's concerns about the necessesity of a burdensome debt break down (and Nick even admits this!) so why is he so emphatically saying that debt is burdensome and only non-burdensome under certain atypical conditions (rather than non-burdensome and only burdensome under certain conditions)? I just don't know.

Krugman is presumably not talking about a bizarre zero growth, all consumption, OLG world (that would be as silly as thinking about a barter economy when you theorize recessions). I always got the impression he was talking about the real world. In the real world income grows, and government invests in education, health, roads, institutions, research, infrastructure, defense, etc.. And in the real world, increasing debt levels means that one person with a growing income will, in the future, pay some money to another person with a growing income. There is no inherent reason why that debt relationship is a burden on the future. Distributional and incentive problems may apply, and of course problems could crop up if you grow the debt faster than you grow your ability to pay it. But the point remains that the unit of analysis (the community) encompasses both the asset holder and the liability holder, so nothing about the debt relationship itself is necessarily burdensome.

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More interesting problems of course arise when you are in a situation that fits Nick's assumptions more closely: spending on the consumption of older members of society. If we want a simple transfer to older members of society because we think the elderly are deserving of such a transfer, then we'd want to prevent that program from being financed by deficits and we'd hire an actuary to make sure everything is above board. We've done exactly that with Social Security. If the costs of this consumption start increasing uncontrollably, then we're going to have to rethink that transfer payment as a society. We're doing exactly that (and should do more of that) with Medicare. But these are both questions of the social desirability of a certain type of transfer payment in a democracy. They have nothing at all to do with debt burdens because we don't pay for Social Security or Medicare by issuing debt. Indeed, Social Security and Medicare are two major holders of government bonds.

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UPDATE: Nick's comment section on this one is voluminous, and I enter briefly on page three and get into an issue that's also raised in this comment section. If you're worried about Dean Baker saying that it's "impossible", then I agree with Nick Rowe that it's not "impossible" for debt to be a burden on future generations. On the question of Dean Baker's word choice I am with Nick. But I didn't even realize that was the real question (I certainly don't think it's the important question). I thought the question was "is public debt like personal debt - if we contract public debt does that mean that the public's future is burdened in the same way that when we contract personal debt our future is burdened by repayment?". The answer seems to me to be "no - it's a very different sort of thing", and we need to push back against this sneaking in of microeconomic thinking into macroeconomics.

17 comments:

Daniel: "...and gets.. well... he pretty much gets Krugman's point about no inherent burden but potential distributional and incentive problems)."

Ummm. No I don't. I get the exact opposite conclusion. There *is* a burden on future generations, *even if* we abstract from distributional questions within one generation and incentive problems.

"It seems that if (1.) the economy doesn't grow, and (2.) old people borrow from young people so they can simply consume more, it is trivially true that debt can be burdensome to future generations."

Which is exactly what those who say "we owe it to ourselves" say is theoretically impossible.

"This is true for any kind of debt - public or private."

Nope. When I borrow, the IOU has my name on it. I must repay what I borrowed.

When the government borrows, the name on the IOU is left blank. It is filled in at some future date when the government chooses to increase taxes to pay for the debt and accumulated interest.

It's not the same.

"Well when we think about debt, we need to think about it in a world where the economy is growing and people borrow either as a result of time preference (they'll pay a premium to consume sooner) or expectations of a rate of return exceeding the interest rate. Under both of those more realistic assumptions, Nick's concerns about the necessesity of a burdensome debt break down (and Nick even admits this!)..."

Nope again. Go back and read my post. It is (as is well-understood) only when the growth rate exceeds the rate of interest, and so Ponzi schemes are sustainable, and future taxes never need be increased, that there is no future burden. But that is exactly the case that Paul Krugman has set aside, when he acknowledges that a bigger deficit now will mean future taxes will be higher.

Look. Paul Krugman is a very very good economist. Much better than me (obviously). But nobody is infallible.

Check the paper by Ball and Mankiw (just posted on Greg Mankiw's blog) if you want a second opinion on whether there can be a burden of the debt on future generations (for reasons over and above lower investment, distorting taxes, and foreign debt).

Abba Lerner's "we owe it to ourselves" view just doesn't work when you start thinking through OLG economies.

re: "When the government borrows, the name on the IOU is left blank. It is filled in at some future date when the government chooses to increase taxes to pay for the debt and accumulated interest."

No - it has the government's name on it. What you're getting at is that the government has somewhat arbitrary and certainly coercive power to tax. That's certainly true. There are concerns about allocative efficiency of government action as a result of this. Certainly. But that has nothing to do with the debt relationship. That difference between public and private borrowing would exist even if we weren't talking about borrowing at all and were simply talking about taxing.

re: "Ummm. No I don't. I get the exact opposite conclusion. There *is* a burden on future generations, *even if* we abstract from distributional questions within one generation and incentive problems."

Go back and read what I wrote that you left in the "..."s. When you relaxed the investment and growth assumptions that you made your conclusion doesn't necessarily hold (but presumably you might have distributional or incentive problems left to talk about). You note that the burden is offset if the money is invested or if there is sufficient growth. You said that in your post.

re: "Which is exactly what those who say "we owe it to ourselves" say is theoretically impossible."

As I noted on your blog, I'm happy to concede the point about "impossible". Those were Baker's words. If you're concerne with that point, fine - I'm with you on that. Krugman seemed more concerned with people who say that the government is like a family and good public finance should mirror good personal finance. That seems like a much more important question to me than Dean Baker's word choice - but if you want to talk about Baker's word choice, I agree with you on that one.

As for your point about Ponzi schemes - agian that all has to do with a world where we're talking about intergenerational transfers. That seems very different from questions of public debt, doesn't it? Our Social Security trust fund takes in taxes (it does not issue bonds) and then buys bonds with those taxes (I'm not sure how it works in Canada). I'm trusting OASDI to keep that Ponzi scheme sustainable one way or another. This all seems quite different from public debt.

Leaving debts to children is better than leaving debts to the current generation.

Why?

The next generation passes on the debt repayment burden to the next generation, which passes on the next generation and so on.

The impact of government debt is spread out over several generations upon generations, thus thinning out further and further.

However, leaving the impact of complete debt repayment on the current generation only will make the current generation much much poorer, and it will be many generations before the next generations catch up with modern standard of living.

(How do you do those italics when you quote?? Never mind; I'm too old to figure it out.)

"No - it has the government's name on it."

Yes, but the government can't pay it by itself. It needs the taxes to pay it. So really it's some unknown future taxpayer's name on that government bond (again, assuming the NPC is satisfied).

"You note that the burden is offset if the money is invested or if there is sufficient growth."

OK. I misunderstood you. Sure, if the government borrows and uses the proceeds to invest in something that will make our kids richer, then that offsets the burden of higher taxes.

(I thought you were talking about the argument that deficits crowd out current investment which reduces future GDP and makes our kids poorer.)

I can't remember who Baker is and who the other guy he was criticising is. I know I'm stepping into some great big American political fight, but I don't really give a damn about that. I don't know who's who in US politics and I don't really care. There are other countries with deficits, not just the US. I'm just concentrating on what Paul Krugman said, and whether his economics is right. I ignored all the other guys he quoted.

"As for your point about Ponzi schemes - agian that all has to do with a world where we're talking about intergenerational transfers. That seems very different from questions of public debt, doesn't it?"

No. I think it's very much the same. Funnily, my co-blogger and colleague, Frances Woolley, who doesn't do macro, noticed in the first couple of comments the direct analogy between the national debt and a PAYGO government pension plan. (Very roughly, I think it's the same between US and Canada.) There are only two differences I can think of: the rate of return on your government pension plan is set by the government, while the rate of return on bonds is set my the market (Fed aside); your assets in the pension plan are not marketable (you can't cash your pension out whenever you want) but bonds are marketable. Neither affect the basic point that both can create an intergenerational transfer.

(Oh it feels so good to have my exams graded, so I can argue this stuff!)

Daniel, it should be mentioned that many sites still use square brackets and capital letters instead of arrow brackets and lowercase letters (HTML vs BB). Essentially, most blogs go with the arrow bracket format while many forums and message boards go with the square bracket format.

I usually don't do that fancy-shmancy stuff and just use regular punctuation.

What we should all be spending more time thinking about is whether or not the interest rate r is above of below the growth rate g.

Because if r is permanently below g, we can deficit finance at zero cost to future taxpayers, because we can just rollover the debt plus interest forever, and never have to increase taxes. There really is a free lunch in that case, and the government ought to let us eat it.

Empirically, it seems that r is sometimes less then g, for many countries (US especially). But can we be confident it will be that way forever?

What I wish I could get my head around is the case where r is sometimes below g, or where we are uncertain whether r will be above or below g in future. There ought to be some way to eat this potential free lunch of deficit financing, but I can't figure it out.

I'm playing around with the idea of NGDP bonds (indexed to NGDP) as a way to exploit this free lunch, in safety. But I just can't think straight on the issue.

One nitpick with your social security example. We actually will have to pay social security by issuing debt (or increasing taxes). As it stands now SS holds nomarketable treasury debt. It really is just the government owing itself money. However, when those securities have to be cashed in to pay back retirees they will have to be paid for with debt issued to the public (or increased taxes). The only thing the SS trust fund does is delay the privately held debt financing of SS and medicare.

Truly "actuarially sound" SS financing would have been financing like, say, an actual insurance company where the SS trust fund was in turned back by assets that could be cashed in to pay back policy holders. Excess SS revenue was used for government consumption of various types (mostly it was just a back door regressive financing of tax cuts).

Also, I don't see why it would matter if r were more than g occasionally so long as r is less than g over whatever time horizon is relevant. That's at least very clear from looking at the massive post WWII debt and how the debt/GDP ratio melted away.

I totally agree, though, you have to be pretty optimistic to think we will ever repeat the kind of r to g relationship we had in the 25-30 years after WWII.

Andrew: "Also, I don't see why it would matter if r were more than g occasionally so long as r is less than g over whatever time horizon is relevant."

That's my thinking too. But I want to try to figure out exactly what "occasionally" should mean in this context, especially when we can't predict the future very well. And also how that "occasionally" ties in with the term structure of the national debt.

There ought to be some way to do it with NGDP perpetuities. But I can't get my head straight on this.

Andrew - Right, but they're holding the debt as an asset. They're not issuing debt to finance social security. If anything, that puts it an even better position, even further away from the problem scenario of deficit-financed consumption of the elderly.

If you want to say OASDI and the federal government is the same thing, then this is just an interorganizational transfer. If you want to say they're different things, then social security actually holds an asset. Either, the point still stands.

Human beings are not dumb. We've chosen to finance consumption by the elderly with taxes, not debt. That's a smart choice.

Think of it like this. Assume we have one giant baby boomer (GBB) who paid into the SS. Also assume that instead of the SS trust fund holding the non-marketable security its given to this one giant baby boomer.

When the GBB retires he will go to the SS office and hand them the non-marketable bond. Now, if SS was like normal insurance, SS would cash in whatever paper/real assets they had bought with the money they got from selling the bond to the GBB and give the proceeds from that asset sale to the GBB.

However, because no assets were bought with the original bond issue, the government will have to borrow money from someone else(or tax the GBB kids) to pay back the GBB.

What you seem to be arguing is that the SS trust fund is both a liability and an asset for the federal government. I'm arguing that it is more strictly a liability with no corresponding asset to back it up.

In the real world the OASDI would be taking "off balance sheet" debt (i.e. money the gov owes itself) and bringing it onto the balance sheet (i.e. an increase in privately held debt). Which is to say that when the GBB retires the implicit liability of SS trust fund becomes more explicitly a liability.

I'm not convinced that is a non-problematic inter-generational transfer.